Investors should not ignore valuations in Europe
The economic picture may not be pretty, but equity prices are well below average, particularly compared with the US
Events in recent weeks have brought some relief to the troubled eurozone.
The announcement of the European Central Bank’s (ECB) long-awaited bond-buying programme on September 6, and the decision by Germany’s Constitutional Court on September 12 not to block the creation of the European Stability Mechanism (ESM), have been broadly welcomed.
European equities have risen to multi-month highs and the euro has caught traders short by rallying to a four-month high of $1.30 (£0.80) against the dollar.
This positive sentiment has helped to ease some of the pressure in the eurozone, most notably short-term funding for government debt in peripheral eurozone member states. However, the bigger problem of economic growth remains untouched.
With government debt burdens remaining elevated, countries need to reduce
deficits and debt ratios – a task complicated by the various austerity measures that are acting as a headwind to economic expansion.
The current macroeconomic picture in Europe is not a pretty starting point, but neither need it be seen as an inescapable vortex. The Organisation for Economic Co-operation and Development may have cut its short-term growth forecasts for Germany and France. However, it still predicts positive growth for 2012 as a whole, which is better than the UK looks set to achieve. July’s surprise rebound in industrial production in the eurozone also suggests some resilience.
That said, economic news for the next couple of months might be challenging. Markit’s composite purchasing managers’ index for the eurozone, which measures new orders in manufacturing and services, remained firmly in contraction for the seventh consecutive month in August.
This probably supports expectations of a fall of approximately 0.5 per cent in economic growth for the currency bloc in the third quarter. With unemployment remaining elevated, the domestic eurozone economy will need all the external help it can get. Happily, both China and the US have turned more accommodative with monetary policy.
In the very short term, there is a danger that the market succumbs to some profit-taking, but equally the moves by central banks might be just enough to prevent an autumn correction.
In these volatile times, however, it pays to take nothing for granted. Events such as the looming US presidential election and uncertainty surrounding the US fiscal cliff still have the potential to unsettle markets.
For investors prepared to look beyond any short-term volatility, however, equity market valuations are inexpensive, particularly in Europe.
The average stock in the MSCI Europe excluding UK index trades on just 10.7 times its predicted earnings over the next 12 months, well below its 20-year average of 15 times and cheaper than the US, which is trading on 12.7 times earnings.